Abstract
We investigate whether corporate governance affects the use of employee stock options (ESOs) in CEOs' compensation packages. Consistent with the managerial power view, we find that firms with poorer corporate governance grant their CEOs higher values of ESOs after controlling for the economic determinants of ESO use. We show that the relation between governance strength and ESO grant values cannot be attributed to two other plausible explanations: omitted economic factors or substitution effects between corporate governance and incentive compensation. Also consistent with the managerial power view, we show that firms with poorer governance in the pre-SFAS 123R period cut back more on ESO grant values for their CEOs after the issuance of SFAS 123R which mandated ESO expensing. Our last finding is consistent with poorly governed firms taking relatively more advantage of the favorable accounting treatment for ESOs in the pre-SFAS 123R period by granting their CEOs excess ESOs, suggesting that agency problems associated with poor corporate governance contribute to excessive ESO use
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